Although interest rates have been rising globally, income-seeking investors are still facing struggles generating income without losing principal. So where should these investors look for attractive opportunities?

The answer may lie outside the U.S.

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Michael Wilson, Morgan Stanley Wealth Management’s Chief Investment Officer, and member of the firm's Global Investment Committee, has been suggesting for some time that investors should keep a watchful eye on non-U.S. equities, since he expects them to outperform U.S. equities. This thinking extends to dividend stocks.

Traditionally, higher-yielding stocks can be found in sectors such as utilities, telecom and consumer staples. While U.S. and non-US companies within these sectors offer comparable yields, investors still need to avoid losses in invested capital.

Morgan Stanley’s Wealth Management team believes a good approach is to focus on a stock’s total return—dividend income plus potential stock-price appreciation. The reason: even when U.S./non-U.S. yields are similar, we often find that the expected total return is higher in the non-U.S. sectors because those companies have relatively lower valuations.

Comparative Valuation

Let’s look at valuations in the telecom sector. Chinese telecom stocks trade at 3.1 times the ratio of enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA) and yield 3.0%. In comparison, U.S. telecoms yield 4.5%, but trade at more than double the valuation—7.4 times this year’s EV/EBITDA.

When looking abroad, it’s also important to differentiate by region. Consider European beverage companies. They trade at a 17.7 price/earnings (P/E) multiple on 2018 expected earnings in comparison to a 19.7 P/E for global beverage companies, though the dividend yield is comparable at around 3.1% for both European and global players. And in addition to attractive valuation, we project benefits from accelerated top-line growth and management-directed cost savings. Lastly, any cut to the corporate tax rate in the U.S. will also benefit their earnings since the U.S. is a major profit pool for these companies.

Sector Diversification

Going global does not mean investors need to give up sector diversification. Outside the U.S., energy, financials and health care sectors yield 4.0%, 3.8% and 2.8%, respectively. This is significantly higher than in the U.S. where they yield 2.6%, 1.7% and 1.7%, respectively.

Within these sectors, we see an excellent opportunity in major European exploration and production (E&P) companies, which have an average dividend yield of 6.1% versus U.S. majors’ 3.5%. Furthermore, we think the earnings and cash-flow outlook is better; the European companies are expected to have mid-single-digit increases in production, while production is declining at major U.S. companies.

In Many Sectors, Non-U.S. Stocks have Higher Yields Than U.S. Counterparts

Source: Bloomberg as of 1/13/2017

Lastly, the European E&P majors trade at 5.4 times EV/EBITDA in contrast with major U.S. companies, where the same metric is 8.6. As these companies trade abroad, many are available to U.S. investors through American depositary receipts, or ADRs, which are priced in U.S. dollars and pay dividends in dollars, too.

These are just a few of the opportunities we are seeing globally. For more information on global dividends, talk with your Morgan Stanley Financial Advisor (or find one below) and ask about our Global Dividend Equity Model portfolio.

Note: This article first appeared in the February 2016 edition of “On The Markets,” a publication of the Global Investment Committee, which is available on request.

Risk Considerations

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Asset-backed securities generally decrease in value as a result of interest rate increases, but may benefit less than other fixed-income securities from declining interest rates, principally because of prepayments.

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.

Investing in smaller companies involves greater risks not associated with investing in more established companies, such as business risk, significant stock price fluctuations and illiquidity.

Stocks of medium-sized companies entail special risks, such as limited product lines, markets, and financial resources, and greater market volatility than securities of larger, more-established companies.

Value investing does not guarantee a profit or eliminate risk. Not all companies whose stocks are considered to be value stocks are able to turn their business around or successfully employ corrective strategies which would result in stock prices that do not rise as initially expected.

Growth investing does not guarantee a profit or eliminate risk. The stocks of these companies can have relatively high valuations. Because of these high valuations, an investment in a growth stock can be more risky than an investment in a company with more modest growth expectations.

Companies paying dividends can reduce or cut payouts at any time.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

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